Chapter 1 – Globalisation and global business dynamics (essay questions)

● Explain phenomenon of globalisation

● Identify the types and drivers of globalisation

● Clarify the implications of globalisation for international business

● Identify emergent themes in discourses on globalisation

Introduction

The term globalisation has been used to reflect the human transition, through innovative selection into modernity. This has caused an advanced form of human assembly. Globalisation depends on your perspective – for victims of colonisation and slavery, globalisation began with the first invasion of communities by the imperialists. The wealth to be found in unexplored worlds was enough to compensate their expedition. The ongoing economic activities in the old world as well as the establishment of the original Silk Road all caused the process of interdependence of people and societies.

On the business front, the British East India Company, the Dutch East India Company and the Portuguese East India Company created a platform upon which modern globalisation could thrive. These developments stimulated trades in cash crops, precious metals, knowledge distribution as well as human capital transportation and technological innovations.

According to Castells, globalisation promotes global commitment and the distribution of ideas through communication and media-related technologies.

According to Appadurai, globalisation is can be seen as the pull of human and nonhuman resources in varying degrees, magnitudes and variations towards the coordinated union of current human experiences.

According to John Tomlinson, globalisation is pinned onto the commands of neoliberal ideology as twin paths of interdependence and growth. Through this the role of cultural integration and social relations through free flow of humanity can be found. The importance of social awareness and knowledge distribution through cross border engagement is at the expense of communal or national identities.

From an economic perspective, globalisation is the launch pad upon which modern interactions and the engagement of market agents and market participants is launched. Economic globalisation involves cross border trades, investments, migration, international capital flows and multilateral trade arrangements.

Types and forms of globalisation

From the supply side the ability of MNC’s to locate production facilities in offshore locations is facilitated by the continued relaxation of various barriers. MNC’s can move a production facility that is underperforming from a region of low efficacy to a region of higher efficiency. This option is favoured to avoid various operational hurdles such as cost reduction, relocation near to actual or potential market, closeness to major suppliers and closeness to major competitors. Example: Silicon Valley.

The face of globalisation (Capitalist globalisation)

Globalisation involves:

- economic integration- the transfer of policies across borders- the transmission of knowledge- cultural stability- the reproduction, relations and discourse of power- it is a global process, a concept, a revolution and an establishment of the global market free

from socio-political controlThis suggests a free society where the invisible interchange of supply and demand regulates sales and purchases.

The good

Globalisation has collapsed the world into a small village. The tremendous increase in world exports is in line with the increase in firms taking advantage of location-specific advantages. Improvements in world exports have contributed to employment creation, trade-creation, national prosperity and human prosperity.

Globalisation has helped improve life expectancy from 52.5 years in 1960 to 71.2 years in 2013. Almost every country has benefited from medical advances that are stimulated by globalisation.

The distribution of technology has helped reduce associated costs and has improved accessibility to state-of-the-art technology by less privileged communities in the world. Cost reduction and accessibility have transformed the way people communicate and interact. The advancement of transport technology has made it faster, safer and more comfortable to travel across global geographies at a relatively cheaper rate.

The concept of location-specific advantages has helped create sustainable jobs in some offshore locations that were previously unattractive for locating production facilities. The multiplier effects of economic gains have trickled down to the greater number of the population and have helped reduce the household poverty level.

The bad

Unfortunately, globalisation is not impervious to weaknesses, fiduciary risks, crookedness and malignity. The allotment of the proceeds is lopsided and the level of underdevelopment in less privileged societies has worsened. Labour maltreatment has been challenged.

Prominent among the arguments levied against globalisation is the unintended consequence of job losses. The pressure created by international competition has necessitated the relocation by MNC’s of their production facilities to lower cost production centres, thereby depriving the higher cost facility.

Africa has not really benefited from economic globalisation. The dependence on its resources has been worsened by globalisation. Many manufacturing firms have been forced to close operations while existing ones are producing far below capacity as a result of intense competition from MNC’s from advanced economies. The dumping of goods on developing markets by MNC’s from advanced economies has worsened market development in the less-privileged communities. Culprits of dumping are agricultural producers from USA and UK due to lopsided regulatory provisions per the General Agreement on Tariffs and Trades (GATT). Agricultural tariffs from the Uruguay Round hurt less privileged countries which the frameworks were meant to help emancipate from abject poverty.

Raw materials from Africa attract no import duties yet it is a crime if any beneficial material is exported from Africa to European Union. As far as tariff barriers are concerned, explains why more than 90% of the global coca-producing countries produce less than 4% of global chocolates.

The main injustice adopted by Western countries and strictly enshrined in the Dispute Settlement Understanding (appendage of the WTO’s framework) says it is fair to subsidise agricultural produce in the advanced economies at the expense of less-equipped farmers in the developing world. Farm produce from Africa is deemed inferior and inadmissible to Western markets except for products regarded as raw materials.

The ugly

With the current form of globalisation, millions of avoidable losses of livelihood are being recorded among smallholder farmers globally especially in the developing world. Within its current form, globalisation advances the interests of capitalism at the expense of the globally poor and the working class. Anti-globalisation in this context stands for the dislike towards the current form of corporate personhood and all forms of economic suppression of the less privileged community and its members.

The first renowned global scale anti-globalisation protest was in 1999 and was targeted at the Ministerial Conference of the WTO where China’s entry into the WTO was approved. China created wealthy Chinese individuals at the expense of the global poor. Cheap Chinese imports have killed so many domestic firms and the few struggling for survival may not be saved owing to the intense pressure for cost reduction in order to compete with Chinese products.

The world has witnessed various socioeconomic mishaps over the past few years proving anti-globalisation protesters right. The 2008/2009 financial crises that originated in USA through financial recklessness spread through the world with devastating effects on less privileged countries. UK recorded its highest unemployment rate in recent years and Italy and France experienced one of the worst periods of political instability for many years. USA was at the edge of total capital market collapse and the resulting social unrest was unprecedented.

All dissensions towards the current form of globalisation have a single goal – to seek a globally inclusive solution to unfair global trade and unfavourable capital market systems.

The journey ahead – new thinking

Across the world advocates of reforms to the current formula of economic globalisation have suggested a rewrite of guiding principles of the allotment of global goods in an equitable manner. This appeals to the global poor, victims of environmental pollution and weak political states which are victims of intimidation from MNC’s. There should be a redefinition of ‘world order’.

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Chapter 2 – Institutional frameworks and the role of government (essay questions)

● Provide an overview of global institutional frameworks

● Outline the importance of the Corruption Perception Index

● Identify the types of worldwide governance indicators

● Elaborate on the role of government in a country’s investment environment

Introduction

The global socioeconomic and political experiences during and shortly after World War II necessitated various institutional arrangements in order to avoid a repetition of global war and to provide solutions to the destruction of war. The institutions created by the Bretton Woods Agreement were the World Bank, the International Monetary Fund (IMF) and the World Trade Organisation (WTO). The idea was that greater economic ties and a degree of interdependence among countries would discourage war. The inception of these global institutional mechanisms created a platform for consultation and dialogue and has fostered a greater respect for the rule of law and for responsible trade and investment behaviour by MNC’s that operate across the borders of many countries.

The workings of institutional arrangements influence domestic businesses and activities involving the receiving (host) country as well as the sending (home) country. A country’s regulatory mechanisms must conform to global norms and if in contravention will be excluded from participation in the global marketplace.

Global institutional frameworks

The main institutions regulating cross-border exchanges of financial instruments as well as goods and services are the World Bank, the IMF and the WTO. These institutions serve as watchdogs for trade relations and the various market agents operating within the global marketplace with specific reference to the exchange of financial assets and trading of value-added products.

The World Bank

The World Bank was created in 1944in USA with the United Nations as its parent body. It was created with the objective of financing the reconstruction of European countries out of the destruction caused by World War II. At first their brief and relevance was marginal but later expanded their focus on global poverty alleviation as well as various initiatives to boost economic growth globally. The World Bank expanded to include three other strategic components namely the International Finance Corporation (IFC), the Multilateral Guarantee Agency (MIGA) and the International Centre for the Settlement of Investment Disputes (ICSID).

Having poverty alleviation as its primary brief the World Bank provides various supports and concessions to sovereign states. A series of funding opportunities are provided to enhance infrastructural development, skills and capacity development, education, healthcare, sanitation and improved quality of life and life expectancy. Its Article of Agreements says it must be guided to the creation of a business environment conducive to international resource flows especially the promotion of foreign investment and international trade. The promotion of international capital flows and intellectual property rights are an important focus.

The World Bank is owned by its 188 sovereign member states and governed by specific statutory provisions. The member states appoint members of the group’s executive leadership through the Board of Governors of the World Bank Group which is responsible for staffing the entire group with necessary workforce for its daily operations. The group’s member governments are regarded as shareholders because they are equity holders. The value of the equity stake is determined by the capital contribution of each member nation and this equity contribution determines the voting powers of the member states. USA has 15.97% of total deciding votes.

These institutions are regarded as being institutions of Washington because of their operational thoughtlessness and structural hypocrisy.

The bank is supported because of its staunch support for absolute economic liberalisation, irrespective of the possible inequality that trade imbalance or payment biases may trigger. Requiring a country with limited industrial capability to open up its domestic market to much more efficient and well-established competitor is sure to be detrimental to that country’s economy.

Another policy was proposing the transfer of national assets to private investors – access to basic facilities, amenities and services be driven by private interests – profit motives, but also national control of crucial services and amenities will be lost.

The third policy of the bank centres on unrestricted application of the doctrine of price mechanism. Demand and supply should regulate the provision of basic amenities and services by a government.

The International Monetary Fund

The primary focus of the IMF in 1945 was to avoid a repeat of the currency devaluations that occurred among the leading economies in 1930’s. The fund was charged with the responsibility of promoting monetary cooperation, capital market integration, ensuring and regulating financial stability, furthering international trade and investment, enhancing employment creation, nurturing global economic growth and development, and creating poverty alleviation globally.

The IMF is controlled and governed by the leadership of 188 countries. The hierarchy of authority and influence is dependent on their global economic power, as well as their contributions to the fund’s capital. The contribution of members is calculated as a quota.

The work of the fund in alleviating poverty through financial assistance, is criticised for policy failure and deceit in its allocation of funds. The fund uses a series of biased eligibility conditions when selecting possible beneficiaries, irrespective of the socioeconomic implication of the required involvement. The funding conditions for developing countries have created economic hopelessness and social disorder.

The most prominent policy was during the 1980’s and was called the Structural Adjustment Programme (SAP). This was intended to address the debt-burdened conditions of developing countries. Evidence suggests that countries became poorer as a result of SAP. Governments in many developing countries assume the responsibility of being the largest employers of labour. Because of this the provision of wages, amenities and other social support are central to socioeconomic stability.

The central focus of SAP was on the reduction of social spending and narrowing the existing social support as a solution to extravagant social spending. The reduction in subsidies for staple foods caused havoc in Africa. In 2005 Malawi was compelled to exchange its surplus grains with Western countries to repay its debt to IMF. Three months later a famine ensued and 35% of the population was threatened by starvation.

The World Bank and IMF ensure the standard of living is lowered in developing countries while locking these countries into debt. The debt repayment erodes the ability of these countries to provide basic amenities.

The World Trade Organisation

The third global institution established by the Bretton Woods meeting of 1944 was originally created under the General Agreement on Tariffs and Trade (GATT) but later transformed into a more robust and effective rallying point for global trade related activities. GATT was rebranded to WTO at the Uruguay Round Agreements in 1995.

WTO serves many purposes:

* Trade liberalisation- removal of all barriers to trade openness. WTO enforces conformity with global rules for the removal of tariffs and barriers that inhibit free movement of goods and services across international borders.

* Negotiation of treaties and agreements – referee for parties in potential trade negotiations. It is important to ensure equal partnership in trade agreements, ensure equity of purpose and equitable allotment of trade proceeds. This helps strengthen the negotiating power of less developed countries.

* Regulate trade relationships between nations- WTO monitors trade relations among member nations and ensure free, fair and unrestricted trade arrangements.

* Negotiate trade dispute resolution / settlement- Responsible for mediating, resolving and settling trade disputes.

* Facilitate economic growth through free trade mechanism- Fosters economic growth through free, fair and unprotected trade.

By promoting free trade, WTO creates an avenue for achieving the optimal allocation of scarce resources in order to generate maximum productivity.

Corruption Perceptions Index

Corruption hinders growth and development. The globally recognised platform for judging a country’s level of corruption is Transparency International. The organisation uses a series of barometers to for measuring corruption.

Ranking high on the corruption perception index does not necessarily suggest clean business practices abroad. Unethical behaviour overseas worsens the perception of corruption in the host countries while home countries are seen as corruption free.

Corrupt practices occur mainly in situations of abuse of power, bribery, lack of transparency in governance, little respect for the rule of law and impulsive governance. The practical implications of corruption perception lie in the cost of doing business in a particular country. The frequency of corruption increases the cost of doing business. Corrupt countries are not particularly attractive to clean foreign investments especially given the difficulties they may encounter for their refusal to pay bribes.

Worldwide Governance Indicators

These are global measures of the efficiency and effectiveness of political leadership. The World Bank has a team of members who report on the performance of countries on specific measurable indicators. The report also covers the individual performance of countries on specific measurable indicators of administrative efficiency. It reports on 215 countries since 1996. There are 6 criteria which are used to judge countries on efficient governance.

1. Voice and accountability Looks at freedom of speech and accountability of political leadership to its citizens. It measures the

extent to which citizens are free to express their views and opinions on issues of public interest without fear of intimidation or persecution. Political leaders must be transparent in their governance and account fully for their conduct and behaviour.

2. Political stability and absence of violence

The peaceful transfer of power from one government to another measures political maturity. The absence of social unrest, violent protests and destruction of lives and property is considered.

3. Government effectiveness Moral leadership should ensure objective policy creation, efficient policy implementation and

rigorous evaluation of policy effectiveness. The skill with which politicians recognise and appreciates efficient civil service is a good indication of high performance.

4. Regulatory quality The quality of regulatory framework, especially the historical architecture of enabling rules and

regulations are important determinants of regulatory efficiency. Any new amendment must be based on historical experience of the people.

5. Rule of law This indicator captures perceptions on the feelings of the populace about the strength of respect

that political leaders have for the rule of law. This indicator estimates the confidence level of the populace as well as foreign investors on the quality of contract enforcement, intellectual property rights, law enforcement, fairness, effectiveness and efficiency of the judicial system and the possibility of abuse of power. The independence of the courts and related frameworks are important.

6. Control of corruption The strength of institutional frameworks to control the incidence and spread of corruption is an

important determinant of the attractiveness of a country for the inflow of of foreign investment as well as global perception of the country’s stability.

World Bank Investment Climate Survey Database

Established in 2005, it was to gauge the level of transparency in the process of establishing a business in any country. It investigates the level of corporate competitiveness focusing on the private sector. There are 7 indicators of competitiveness.

1. Firms perceptions Evaluations of the extent to which a specific range of problems are regarded as major or minor

hindrances to the effectiveness and efficiency of the day to day operations of a business. This is an important measure of the likelihood of continued investment support for the country under consideration. The measure is an important determinant of a country’s potential to attract investments from both within and outside the country. Objective captioning of perception is questionable and tainted with biases.

2. Infrastructure and services For a business to be sustainable it requires access to necessary infrastructure and services. The

availability, access and affordability of basic infrastructure will influence the investment climate of a country. The lack of facilities raises the cost of doing business and discourage entrepreneurial participation in available economic opportunities.

3. Finance Working capital is the support of every business. The availability of and access to, required financial

support for a start-up as well as existing business is an important gauge of the conduciveness of the investment environment of a country. The ability of firms to efficiently manage their operating finance is important.

4. Government policies A political leader with a democratic philosophy will embrace a free market economy and provide an

enabling environment for entrepreneurial development. A political leader with a socialist philosophy would promote extensive sate market participation.

5. Conflict resolution and crime Labour dispute that cause violent protests unnerve investors and hurt the perception of investors on

the investment climate of such a country. Countries with strong labour laws, resilient labour unions and unregulated labour markets rate very low on these counts. This rating also covers the ability of state institutions to settle disagreements. Crime erodes social stability. Countries with unsuccessful conflict resolution, violent protests and aggravated crimes influence the perception of a country in a negative light as far as having a conducive investment environmental rating is concerned.

6. Capacity and innovation Input resources are converted into finished products through production processes with the aid of a

qualified and skilled work force. The country’s competitiveness will be influenced by the availability of a workforce capable of helping a business achieve its targets and long term objectives as well as an appropriate human resources strategy. The ability of a country to provide the necessary support to spur innovation in a way that aids a firm’s competitiveness will influence the country’s rating.

7. Labour relations Labour relations and the strength of organised labour unions as regards dispute resolution is

important for a healthy operational environment as well as a reduction of lost productive hours as a result of prolonged strike actions. Labour relations should be aimed at stimulating strategic human capital engagement and interaction with other resources to bolster a favourable perception about the investment climates of a country.

Doing business: regulations and their enforcement

The effectiveness of the entire regulatory system is measured through the practical applications and enforcement of rules and regulations that are promulgated by the government. These rules and regulations provide a competitive platform for business operations as they not only suggest permissible competitive processes but also spell out the possible punishments for firms that breach them. Firms may use economies of scale and shut out competition but should not collude.

The general perception about the efficiency and effectiveness of regulatory device in a foreign market is best measured by investors through a lack of bias in the application and implementation of regulatory tools. These tools are important controlling and monitoring measures to ensure market efficiency.

These frameworks are best measured through the enforcement barometer. The argument is for strongly formulated policies and the efficacy of the implementation process.

Pressure for effective enforcement of regulatory supervision arises from the need to ensure adequate protection of contractual obligations as well protection of intellectual properties which are central to foreign market engagement. MNC’s invest heavily in research and development and need to protect inventors of technologies.

In the developing world the challenges of policy formulation and implementation as well as enforcement of regulatory instruments is problematic. Supervisory capacity is weak due to poor enforcement mechanisms.

Public Integrity Index

This measures the accessibility of citizens as well as the existence, efficiency and effectiveness of institutions that hold a government accountable and responsive. Good governance requires proper

assessment. Measure promoting integrity and countering corruption are no exception. In a global economy good governance is seen as a parameter of competiveness and investors account for such factors when deciding where to locate their operations. Governments are responsible for providing evidence based information on the results of their policies. This keeps them accountable.

Transparency International developed a scientific toolkit for measuring the extent to which the civil service of a country is judged free from corrupt practices. The integrity of a political system and leadership are best measured through the quality of the social services that are delivered to the people, as well as the extent of fiscal discipline that is demonstrated by the political leadership.

The role of government

Governments have a role to play in ensuring peaceful coexistence among their people and the global world at large. It must ensure the realisation of fundamental human rights and unrestricted access to basic services. It should also create an investment friendly environment in which all market participants are treated the same and equitable access to operational facilities.

Respect for the rule of law

The components of the principle of respect for the rule of law consist of 4 major universal components: accountability, equitability, accessibility and integrity. Respect for the rule of law manifests as follows:

● The government and its officials and agents, as well as individuals and private entities are

accountable under the law. A deep sense of accountability means government officials are guided by responsible, professional and selfless motives.

● The laws are clear and unambiguous, publicised, stable and just, are evenly applied and

protect fundamental rights. Inability of judicial institutions to deliver judgment in good time, fairly and equitably may be equivalent to disrespect for the rule of law.

● The process by which laws are enacted, administered and enforced is accessible, fair and

efficient. The regulatory system should be equitable in the administration of justice and representative of every legal person without fear or favour.

● Justice is delivered timeously by competent, ethical and independent representatives and a

neutral jury who reflect the makeup of the communities they serve.

Adjudication and enforcement

The credibility of the judicial system is based on trustworthiness of the entire judicial process, the integrity and knowledge of the bench of judges, as well as the efficiency of the law enforcement agencies. An incorruptible judiciary rates highly in the perception of investors.

Effective enforcement of a judicial verdict is important. Capability and competence of the police force and correctional services kicks in after a verdict. Timeous implementation of judicial findings shows the efficiency of the regulatory institution and enhances investor confidence.

Civil liberty and fundamental human rights

This principle encapsulates major rights and privileges that are essential and indispensable to every human being and should be applied equally irrespective of nationality, race, gender, social status or religious affiliation.

United Nations General Assembly on 10 December 1948 adopted Resolution 217 which incorporates 30 globally accepted provisions. Afterwards came the Universal Declaration of Human Rights.

Peaceful electioneering and transfer of power

Central to the political economy is the electioneering process and peaceful transfer of power from one democratically elected leader to another. Countries with peaceful political transmissions are more attractive for foreign investments.

Transparency in governance and institution

The state collects taxes and rates and appropriates the revenue generated in a transparent and equitable manner.

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Chapter 4 – Ethics and corporate governance in international business

Introduction

Agency risk – risk of management acting opportunistically and in own best interests as opposed to the interest of the shareholders.

This gives rise to need in corporate governance (CG).

CG applies to domestic as well as multinational corporations (MNC’s)

CG is concerned with structures and processes associated with management, decision-making and control and governs the organisation from the top making the board of directors accountable for performance of the business plan.

International business, government and societies: ethical implications

Broad sense – CG refers to externally exerted control, for example – state, judiciary system, regulatory bodies. The purpose is to set ground rules to protect interested stakeholders and market

Narrow sense – CG refers to the internal control of organisations. Pinpoints director’s responsibility to strategic direction, executive action, supervision and accountability. Also to supervise management.

Inclusive approach to CG - accountable to all stakeholders, including government and society

Ethical – what is not only good for oneself but also consider good of others.

4 core values:

● Fairness

● Accountability

● Responsibility

● Transparency

CG imposes ethical obligations on organisations, including MNC’s

Theories of business ethics

Friedman’s doctrine

Pursue profit maximisation at all costs so long as it complies with rules of law.

Investment in social expenditure must be kept to a minimum and only comply with business norms and legal requirements

Shareholders can invest in social projects in private capacity

Cultural relativism

Business ethics are a reflection of a particular culture “when in Rome do as the Romans do”

Differences in societal values, norms and customs

The righteous moralist

The home country’s standard of ethics is what must apply in the host country where the MNC is operating

Certain behaviour may be offensive to local managers

The naïve immoralist

Expatriate managers working in host country follow business practices of other MNC’s, for example bribery of local officials may be acceptable in host country but remains unethical

Utilitarian ethics

Traditional utilitarian approach – David Hume, Jeremy Bentham and JS Mills – the moral worth of actions is determined by their consequences.

An action is desirable if it leads to the best possible balance of good consequences over bad consequences.

Maximisation of good and minimisation of bad.

The best decisions produce the greatest good for the greatest number of people, for example cost-benefit approach to risk assessment (only if benefits exceed the cost will an outcome be pursued)

Drawbacks – measurement of utility such as the cost of job losses, how does one measure happiness

Kantian ethics

Immanuel Kant – everyone should be treated as a free person equal to everyone else

Everyone has a duty to treat others in this way

People have dignity and need to be respected as such

Rights theories

Human beings have rights and privileges that transcend national boundaries and cultures

Managers should make ethical decisions and not pursue actions that violate rights

United Nations Declaration of Human Rights – all human beings are born free and equal in dignity and rights. They are endowed with reason and conscience and should act toward each other in a spirit of brotherhood

Everyone has the right to work

Everyone has the right to be paid equal pay for equal work

Everyone who works is entitled to just and favourable remuneration, providing adequate support for their family, including social benefits

Everyone has the right to form and join trade unions for the protection of their interest

Example – MNC’s dumping waste into water without compensating citizens

Justice theories

Distributive justice – John Rawls

Each person should be allowed the maximum amount of basic liberty, compatible with a similar liberty for others, for example right to vote, freedom of speech.

That once basic liberty is ensured, inequality in basic social goals (income and wealth distribution) should be allowed only if it benefits everyone.

Difference principle – no relevant differences among people that can justify unequal treatment.

Corporate social responsibility and sustainable development

CSR – the ethical behaviour of a company towards the society they operate in.

Business must contribute to the sustainable economic development by working with employees, their families, the local community and society to improve their lives. They must share a part of their profit.

CSR uses the inclusive stakeholder approach

Examples of CSR – Black Economic Empowerment, health concerns, education, Ubuntu

Corporate Social Responsibility reporting – the problem of disclosure

Motivation driving triple bottom line reporting (economic, social and environmental)

CSR reporting – transparent, reliable and accurate – to build confidence of stakeholders

CSR reporting – sustainability reports

Impact of MNC’s on economy, environment, human rights, labour practices, product responsibilities, working conditions and social performance

Multinational enterprises and global governance

Global governance takes form of treaties, customary international law and formal and informal institutions.

The global institutions include United Nations, World Trade Organisation and International Monetary Fund.

The regional institutions include BRICS.

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Chapter 6 – The global monetary system and foreign exchange market

Introduction

Money market:

● Deals primarily with trading of short term financial instruments

● High liquidity and large yields

● Financial commitments are reversible

● High volatility and high risk but high short term returns

● Central bank – bankers’ bank which regulates entire financial and capital markets of the

country

● Amending possible effects from failures of external markets

Component of money markets:

1. Commercial banks

● act as intermediary between central bank and consumers of financial services

● act as intermediary between lenders fo surplus units and borrowers from deficit units

● safeguard lenders’ investments and deliver agreed dividends to investors

● reinforcing trust by using control measures to carefully select creditors and minimise bad

debts2. Discount houses

● Used for borrowing huge sums of money for short term returns

● Trade using bills of exchange

● There are 3 types of bills

i. Domestic bills – financial instruments issued by domestic market participants to raise immediate funds with possible maturity in not too distant future eg. Post-dated cheque

ii. Foreign bills – international dimension as guarantee that payment will be madeiii. Government treasury bills – backed by government of issuing country, short term ie.

Not more than a year. It is used to regulate money supply in the economy, to tame inflation and to mitigate exchange rate volatility

Evolution of the global monetary system

During the World Wars countries preferred to receive international settlements in gold rather than a convertible currency – this became known as the gold standard era

The instability in the financial market worsened exchange rate volatility which caused the abandonment of the floating exchange rate which had been adopted by countries at the time.

The shortage of gold supply triggered global financial crisis.

Policy initiative from the Bretton Woods convergence was to create a globally acceptable platform for financial transaction in a reasonable convertibility environment.

The gold standard (1876 – 1944)

● First attempt to create a globally acceptable unit of account, a standard metric for

accounting and exchange of goods and services

● Tied the monetary value of currencies to a relatively scarce precious metal – gold – with a

stable value as a guarantee of store of value

● Price mechanism helps to ensure market safety

● Economic depression of 1930’s along with the instability in the economic and political

environment ended the gold standard eraThe Bretton Woods agreement and the fixed exchange rates system

● 1944 – pathway to global prosperity

● addressed gold standard weaknesses, currency volatility and post-war popularity and

strength of the US DollarAfter WW II there were the following developments:

● emergence of USA as superpower and global economic force

● Protectionism as a policy drive to catapult countries out of economic crisis

● Increasing popularity os US Dollar as medium of exchange and store of value

● Recovery packages and structured interventions from USA – Marshall Plan of 1948 and China

Aid Act of 1948

● Global acceptance of the gold exchange standard as a uniform measure for the clearance of

foreign currencies in exchange for US DollarsThe conference created global financial institutions such as International Monetary Fund (IMF) as the central institution to craft, implement and supervise the ground rules of the international financial market.

Existing global monetary values were fixed against the US dollar and every country held their foreign reserves in US dollars instead of gold.

Former British Protectorates and Common Wealth nations fixed their own currencies against the pound and foreign reserves were held in pounds – issued by the Bank of England.

Upon creation of the IMF, US dollar assumed 3 functions aimed at ensuring lasting financial stability:

1. Intervention currency – tool to regulate swings in value of domestic currencies. The Reserve Bank buys and sells the US dollar to stabilise domestic currency value (forex intervention) and to preserve the value of the domestic currency.

2. Common denominator for all currencies – single currency for store of value means that every currency revolves around USD.

3. Standard of value for different national currencies – globally accepted measure of monetary value

World Bank created post-war to aid reconstruction and recovery from socioeconomic destruction.

In 1973, global financial market became unmanageable when US dollar weakened.

The floating exchange rates system (1973 to date)

Central banks serve as country’s representative of IMF for market monitoring and supervising, and through the National Treasury is curator of national fiscal and monetary policies.

By 19 March 1973 the international monetary / currency system had changed to flexible (floating) exchange rates.

Floating nature of currencies based on the price mechanism (forces of supply and demand) eliminates artificial value assumptions of currencies.

Clean floats – unhindered market mechanism allowed to determine exchange rates

Dirty floats – any intervention in market to influence exchange rates because does not portray the true value

Market supervision is required because the market may work badly.

The global monetary organisations

The global monetary system is a consolidation of all elements of monetary transactions across international borders.

It assembles savings from surplus economic units and allocates credit to deficit production units.

It creates and manages money as national legal tender and international store of value.

Reinforced by regulatory bodies

Currency conversion / convertibility

Conversion – the process of converting one domestic currency into another

Reinforced by principle of willing seller and willing buyer

Partial convertibility is the convertibility of a transaction into a current account instrument but subject to regulatory approval before settlement.

Convertibility – the ease at which a currency can be exchanged for another foreign currency within confines of applicable supervision.

Main function of monetary organisations within currency conversion process are to determine the value of local currency that is being exchanged for a foreign currency and to keep accurate records of the profile and volume of transactions that individuals conduct within financial markets.

This is to regulate and supervise the flow of foreign currency in and out of the country.

Currency / exchange rates determination

Value of currency is determined by price mechanism – demand and supply.

The more foreign investors demand goods and services from a domestic economy, the more the currency of that country will be required to pay for those demand, thereby generating surplus demand. The excess demand will push up the price of the currency.

Currency worth – the overall value of the currency relative to other currencies into which domestic currency can be converted.

Determinants of currency worth:

1. State of the domestic economy – overall health and capacity of the economy, the larger the size the greater the currency worth

2. Debt level of an economy – the weight of the debt compared to national GDP3. Inflation level and the performance of the national current account – trade balance (imports

less exports) and foreign earnings (foreign receipts versus foreign transfers)4. Political economy – state controlled versus free economy, peace versus civil unrest

Foreign exchange markets

Global demand for tight controls on international flows of financial resources and instruments.

The foreign exchange market is the name attributed to every market agent that performs legitimate exchanges and conversions of domestic currency into foreign currencies.

The role of foreign exchange markets

1. Transfer - forex market facilitates the transfer of money from 1 country to another through the banking network. MNC’s invest in countries that offer easy transfers of their earnings from their offshore investment locations back to their home countries

2. Credit – financial institutions generate credit from surplus units of the economy and lend it to deficit units through intermediation (maturity transformation)

3. Hedging – reduce the effects of possible foreign exchange volatility on the performance of an organisation

Exchange rates and domestic price levels

The law of one price and purchasing power parity

The law of one price – price of assets, services, goods and resources should be equal across global geographies when products are denominated in a similar currency. Price equity is established when economic activities are priced fairly in an efficient free market system.

Theory of the purchasing power parity (PPP) – prices of products should be comparatively the same when adjusted for national differences in inflation and exchange rate variances.

Absolute PPP – prices should be equal across countries with disregard for effects of inflation and exchange rate differences

Relative PPP – prices adjusted across countries as influenced by variations due to inflation and exchange rates.

Exchange rates forecasting

Speculative econometric models – scientifically project the possible behaviour of a specific currency at a future period with variables of interest (growth, net export). Not an exact science, MNC’s rather hedge financial risks.

Foreign exchange exposures / risks

Foreign exchange exposure is the risk associated with activities that involve a global firm in currencies other than its home currency. It is the risk that a foreign currency may move in a direction which is financially detrimental to the MNC.

There are 3 types:

1. Transactional exposure – measures the effects of exchange rate volatility on outstanding obligations that existed before the exchange rate changed but which were settled after the exchange rate changed. The MNC must pay its foreign suppliers in foreign currencies while receiving local currency from its customers.

2. Translation exposure – deals with the possible loss of financial value on the accounting books of a company in the process of converting the finances of a company’s subsidiaries. It affects the conversion of foreign assets and liabilities into local currency.

3. Economic exposure – the extent to which the economic value of a firm can decline due to changes in the exchange rates. Strong, volatile exchange rates and political tension between MNC’s and the host country affect the book value and operating cash flows of the MNC negatively causing a negative impact on the MNC’s share price.

Challenges of foreign exchange exposure have direct and indirect impacts on the cost of doing business. MNC’s are concerned with profit maximisation at the expenses of other stakeholder interests. This risk exists for businesses where the value of its future cash flows is dependent on the value of foreign currency where the business operates.

Managing foreign exchange exposures / risks

● Forward exchange contract – allows a company to set exchange rates at which it buys or

sells a given quantity of foreign currency in the future. Businesses agree to purchase an amount of foreign currency on a specific date in the future at a predetermined exchange rate. FEC’s mitigate fluctuations in exchange rates.

● Foreign currency options – enables an MNC to purchase or sell foreign currency under an

agreement that allows for the right (but not the obligation) to undertake a transaction at an agreed future date. . FX options have the advantage of being flexible when trading whilst also mitigating volatile exchange rate fluctuations.

● Perfect hedge – simple method to match any outgoing foreign currency payments against

foreign currency inflows received at exactly the same time.

● Foreign currency bank accounts / loan facilities – used when timing of inflows and outflows

does not match. Surplus foreign currency is deposited into foreign currency accounts for later use, or by borrowing foreign currency for foreign currency purchases and using foreign currency to repay the loan.

Chapter 7 – Evolution of Global Markets and African Imperatives

● Provide an overview of the evolution of the global capital market

● Distinguish between capital markets and financial markets

● Explain the role of the capital market in an economy

● Elaborate on the dynamics of the African capital market

● Highlight the challenges of capital market development in Africa

● Discuss the concept “Africapitalisation”

Financial markets play very crucial roles in the functioning and conduct of international business.

Evolution of global capital markets

The banking system was developed because of the economic desire to seek surplus funds within the economic system and to channel these surplus funds optimally to economic agents that need the funds to fuel production. As early as 2000BCE, the Neo-Babylonian Empire had developed a banking system with saving and lending being promoted. This process of banking also took place in the Roman Empire. In Rome and Greece the use of finance merchants formed a part of daily life. Some of the financial instruments used today were developed from the ancient European banking processes.

The early practice of banking was mainly conducted by individuals and private investors. Governments only got involved when they charged the bank with collecting taxes on their behalf. As these banks became more developed, government became more involved. The governments saw that the banks were a strong source of income for them. Due to the series of regulatory challenges that accompanied the development of these banks, countries established public banks.

The earliest government bank was the Bank of Venice established in 1157, followed by the Bank of Barcelona in 1401, and the Bank of St. George, Genoa in 1407. The Bank of Sweden established in 1556 was the first state-owned bank. In the UK, goldsmiths contributed to the establishment of the Bank of England in 1694 which coincided with the “gold rush”. In 1921, the Imperial Bank of India was the forerunner in the establishment of modern banks, followed by the Reserve Bank of India in 1935 to perform the functions of a central bank.

The origin of the equity market was in Italy in 1171 when in order to finance a war, Venice forced its inhabitants to loan funds upon which interest was paid on the amount borrowed until the loan was repaid. Creditors were allowed to convert the bonds to cash with any buyer of the security. In the 19th century, the UK was the first to adopt stock trading and this was during the Industrial Revolution. The USA followed in the 20th century post-industrial revolution. Most of the equity markets were formed in Europe or by Europeans abroad.

Equity markets are the process through which stocks are traded both by exchanges and over the counter. This market consists of the primary markets and secondary markets.

Primary markets are financial markets where enterprises issue their newly issued shares and bonds (Initial Public Offerings-IPO) directly to the public for subscription. While the shares go directly to investors, the funds generated go directly to the enterprise that offers the shares/bonds for sale.

This market offers the enterprise the only moment to receive cash proceeds in exchange for selling securities to the public/investors.

Secondary markets are financial markets where securities are traded after being offered initially in the primary market. Most trading is done in the secondary market.

Stock markets were developed to restructure in-built shortfalls in the process of credit allocation through the banking system. Banks are biased in credit allocation especially where there is tight government control over the ownership of the banks. An organised and efficient stock market stimulates investment better than the banking system. Stock markets also provide individuals with an option of less risky and more liquid, productive investments at lower costs compared to banks.

The role of the capital market in an economy

A financial market is a market where short term financial instruments are bought and sold (traded). The most important part being swift gains within a short period. Most financial instruments used here are designed to hedge against currency/financial risks.

The capital market is where long term financial instruments are traded. It is more resilient and durable. It provides a cheaper platform for corporations to raise funds for capital-intensive projects, especially where projects have long-drawn-out payback periods. The main components are the equity markets (stock exchanges, investment banks) and the credit markets (development commercial banks, bond markets, insurance houses, financial instruments of intermediation). Capital markets enhance economic growth impacting developing economies more due to extensive capital gaps.

The functions of capital markets are:

● Provide alternative source of finance for projects with long term repayment periods while

also providing a cheaper cost of capital than commercial banks. Also give businesses the opportunity to raise cheaper funding through IPO’s or secondary offerings.

● Bridge gaps in long term financing through stock exchanges and development banks. Viable

capital markets in emerging economies provide opportunities for small businesses to participate in capital market initiatives. This creates promote a spirit of savings among poor households.

● Provide an access for international and domestic portfolio investors. This enhances the

supplementation of low domestic savings making it possible for governments to seek and access funding for growth inducing activities. A local capital market may integrate its operation with the global network and create a higher liquidity ratio in the domestic market.

Dynamics of the African capital market

The successful growth of financial efficiency depends on historical capability, developmental leadership, institutional efficiency and integration with the global capital market. Western countries’ markets are more capitalised and efficient. When facing crises speed of recovery is rapid.

Capital markets in developing countries, especially in African counties are weaker, less-capitalised and suffer system failures and widespread socioeconomic and political weaknesses. Capital market evolution in Africa has been sluggish. The Egyptian Stock Exchange was established in 1883 while the JSE was in 1887. These markets are dominated by resource listing.

Regarding banks, the Mauritius Commercial Bank and SA’s First Bank were the oldest on the continent, established in 1883. Then in 1884, Bank de Tunisia was followed by First Bank of Nigeria in 1894. These banks were established without Western connections. Their capitalisation enabled institutions of Western power. After political freedom, Africa’s markets became more aggressive in order to redress relentless capital gaps.

Structural Adjustment Programmes (SAPs) were introduced by IMF and the World Bank in the 1980’s in Africa to challenge rivals of capitalism.

The main damages caused to African countries by this policy originated from the swiftness with which the IMF and World Bank stimulated the recovery of the US dollar from its problems with currency runs between 1979 and 1980. The recovery was through destructive macroeconomic interventions by ruthless lenders. The bulk of loans to Africa were in the form of developmental project financing for projects designed and executed by Western governments. These loans never reached African shores but were quick to repatriate the cost of capital back to Western economies. These loans crushed economic productivity in Africa and created a huge capital gap. The free market economy was forced onto Africa in order to stop socialist ideology. This was also done to ensure free access to African resources and markets. This weakened Africa’s remaining strength in their fledging capital markets.

Thanks to the resource booms, many African capital markets have improved in efficiency and capitalisation and have attained global recognition. Recently the capital gaps have been bridged and projects have been financed through domestic debt and bond markets. This has reduced the cost of capital and strengthened Africa’s relevance in the global markets. Due to less integration with Western markets, Africa has avoided effects of Western market failures. Efforts towards intracontinental integration has spurred the “Africapital’ agenda.

“Africapital’ is the development of home-grown capital market acceleration and improved capitalisation across the continent through determined dedication and strong commitment from African patriots within the continent and in the diaspora.

Challenges that hinder capital market development

Capital flights from Western MNC’s, colonisation and economic deprivations inflicted on Africa by Western superpowers are responsible for the underdeveloped capital markets.

Due to economic hardship many skilled Africans relocated in the West creating the brain drain of human capital. This resulted in weak financial capacity, inability of state provided amenities, erosion of trust and confidence in political leadership, crime, violence, intolerance and socioeconomic and economic uneasiness. The resource boom could have helped salvage Africa’s future and prosperity but the West continues to enable Africa’s dependence on their appalling aid and humanitarian support which has only plunged Africa into utter poverty.

The West continues to view Africa in a negative light. According to the West, Africa’s adoption of import substitution development was counterproductive. They view the effects of wars and civil unrest in Africa to have a devastating effect on the macroeconomic basics. Poor economic performance is blamed on leadership failures. Little is said about the West’s role. Although Joseph Stiglitz, former chief economist of the World Bank highlighted the negative effects of globalisation and financial liberalisation on Africa.

The widespread corruption in Africa is a major hindrance to capital market efficiency. Self-interest has created rivalry between the biggest economies in Africa whereas the markets should be

integrated and united. Information on African capital markets is distorted by Western propaganda making it less attractive to potential investors, venture capitalists and foreign market participants.

Another constraint to African capital market development can be attributed to low household savings. This negatively affects wealth creation through financial intermediation.

The new thinking on capital market development – Africapitalisation

Renewed efforts by political and corporate agents have improved capital markets. Dangote Group signed a financing deal of USD 3.3 billion to finance construction of a petroleum refinery. The funding was raised mostly through domestic financial instruments.

Strong integration of capital markets within Africa will help improve functionality, efficiency and strength of markets across Africa in bridging capital gaps and financing developmental projects. The creation of foreign money markets and further integration of national market platforms is an example. There is such an arrangement between the listings of Nairobi Stock Market and Uganda Securities Exchange. An increase in these kinds of arrangements will strengthen market efficiency and improve capitalisation.

The ability of governments to promote cultures of savings through restructuring of financial markets would boost efficiency and effectiveness of capital markets and the ability of domestic markets to finance developmental projects that create jobs and alleviate poverty.

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Chapter 9 – cross-border Investment and Trade

● Critically evaluate the importance of international trade and investment flows

● Identify the patterns of international investments, while highlighting the risks involved

● Confirm and debate the dynamics of capital controls

● Justify the applicability of international trade theories

● Debate the arguments advanced against free trade movement

● Explain the purpose of non-tariff barriers, given the importance of tariff barriers

Introduction

All countries embrace the principles of international trade and investment. The volatility of cross-border direct investment and the constraints that regulate these investment flows can lead to restrictions on capital flow.

Patterns and types of investments

The latitude governing International investment flows can be shown in the case of cross-border bank flows and transition of financial assets across borders. Cross-border business activities need to be supported by banks and other institutions that provide the financial assets required by these activities.

An integrated global economy needs a financial system to funnel capital from counties with a surplus of savings to those with a surplus of investment opportunities. Banks provide capital for investment purposes and the stock exchange allows foreign access to domestic equity capital.

An example of this type of integration relates to the benefits flowing from a single currency, like the euro. The European Central Bank ensures that the monetary policy is applied consistently across members of the Eurozone.

This integration provides for stronger cross-border banking and investment flows. EU member countries can be the primary beneficiaries of this type of investment which increases the capital flows across Europe’s borders. This is an example of financial globalisation.

While these international capital flows finance fixed capital investments, they also can support the funding of government deficits. This is a risk of international capital migration and the dangers inherent in the deployment of capital resources in foreign countries.

Barriers to international investments

Investment barriers can be regulatory and may be in the form of capital controls. Barriers exist which restrict direct capital flows across international borders, such as investments destined to fund projects in host countries. Such barriers include:

● Risks associated with servicing capital debt due to uncertainties relating to interest rates,

exchange rate risks and possible currency devaluation

● Costs impairing certain types of capital borrowing

● Irresponsible capital borrowing by certain countries which resulted in limits being imposed

on this type of investment funding- funds are used to finance budget deficits due to recklessness of recipient country

● Prospect of borrowers being unable to repay their capital loans on time which increases the

cost of capital for other borrowers who do not default

● Imposition of taxes on foreign currency inflows by certain governments, which can deter

international capital flowsCapital controls

Capital controls are imposed to curb capital flight. Often this is due to a country’s failing banking system which may result in bankruptcy, or as a result of a country’s credit rating being downgraded.

Capital controls can be prohibitions or quotas on the amount of money that can be moved out of a country. They may be imposed due to a financial crisis facing a country.

Recently capital controls are more lenient and assume the form of market-based controls such as taxes on certain types of capital flows, including changes to withholding taxes and certain liquidity requirements applicable to foreign funds. These types are more compatible with the globalisation process.

A market-based approach to capital control often targets a debt crisis even if short-lived. This is when a country manages to get out of its recession sooner than expected and money starts to flow into the country, often necessitating a financial transactions tax on the purchase of equity or bonds.

The goal of these controls is to manage exchange rate fluctuations and render local banks less vulnerable to a sudden outflow of capital. These measures restrict capital mobility limiting capital flows that could push a currency far above its intrinsic value and widening the country’s trade deficit. They also prevent a borrowing frenzy which can cause financial instability.

The removal of capital controls could speed up the flow of much needed funds so as to boost savings in a country thereby providing for the poor while deepening the financial sectors of wealthy countries. This could encourage a more efficient allocation of credit rather than having to depend on the IMF for loans.

These measures are about timeous interventions by governments. The timeous imposition of capital controls is important for countries with high capital inflows.

Such controls come at a cost. They impose an administrative burden on governments – they must discriminate between different types of credit to discourage activities aimed at yielding quick profits.

Macro and microeconomic consequences must be considered – impact on foreign exchange markets and trade balance. All variables must be considered so as to optimise benefits.

Recent developments in international trade

The post-war period with its changing economic power has served as a catalyst for international trade development. This includes both regional and multilateral trade development. Trade liberalisation has taken on 2 approaches:

1. Focus on peace, safety, health and technical standards, currencies, treatment of foreign investors, protection of intellectual property, telecommunication services and enforcement of labour and environmental protection.

2. Concentration on reducing tariffs – ChinaDue to trade developments, trade pacts have been concluded. One such initiative are the free trade agreements entered into across EU countries.

The establishment of Regional Trade Agreements (RTAs) has complimented these agreements. RTAs compliment multilateralism. RTAs could eventually account for a huge share of global trade.

Dominant among such trade coalitions is the WTO. WTO is responsible for policing the world trade system, ensuring member countries adhere to the rules laid down in trade treaties. WTO has enormous scope and influence and facilitates the establishment of additional multilateral agreements between WTO member countries.

WTO rules allow rich countries to benefit from poor. It inflicts damage on more vulnerable countries by relying on the force of international law for policing compliance. WTO’s rigid implementation of trade promotion is a threat to the democracy of weaker members. WTO panders to big governments and the interests of multinational enterprises particularly to dispute resolutions.

The slow growing world economy has caused many WTO members to be reluctant to reduce trade barriers. Many of the ills of the global economy are being blamed on the WTO, including rising unemployment, environmental degradation, poor working conditions in developing nations, falling real wage rates and rising income inequality. This is worsened by major trading nations’ refusal to play by international trade rules.

WTO still has a viable agenda to pursue – need for feasible anti-dumping policies, to confront aggressive protectionism and lack of protection for international property rights.

International trade theories

These theories assume that free trade occurs, countries should not limit imports nor exports, and the market determines which producer survives as consumers buy those products that best suit their needs.

1. Absolute Advantage (Adam Smith) Different countries produce some goods more efficiently than others, implying that consumers should not have to buy these goods domestically, when they can buy the goods more cheaply abroad. In the absence of any restrictions, each country should specialise in those products that give them a competitive advantage. Countries should shift to efficient industries rather than compete in inefficient ones. The natural advantages are derived from the country’s climatic conditions, access to certain natural resources or the availability of certain labour skills. Acquired advantage confirms that most goods produced today are manufactured rather than being a product of agricultural production. Countries that are competitive in manufactured goods have an acquired advantage which enables them to produce a unique product. Advantages in process technology stems from the ability to produce a similar product easily distinguishable from competitors. Acquired advantage through technology, can create new products while displacing old ones, and substituting traditional trading partnerships with alternative ones. One country has absolute advantage in the production of a product when it is more efficient than any other country in producing it.

2. Comparative Advantage (Ricardo) This theory suggests that it is in the interests of a country to specialise in the production of those goods that it produces most efficiently and to buy goods it produces less efficiently from other countries. These efficiently produced require fewer input resources. A country’s competitive advantage lies in producing more of a product that requires fewer input resources, even though it has an absolute advantage in producing both goods it needs. When engaging in trade with another country, these two trading countries can increase the combined production of both products, while consumers in both countries can consume more of both products. Both countries benefit from reciprocal trade due to the comparative advantage of specialisation. The theory of competitive advantage holds that the potential world production increases with unrestricted free trade, including countries that lack an absolute advantage in the production of a particular product. All free trade participating counties realise economic gains.

3. Heckscher-Ohlin Theory of Factor Proportions They argue that competitive advantage arises from differences in national factor endowments (resources such as land, labour and capital). The result of this is that nations have varying factor endowments, and thus differences in factor costs. The greater the factor endowment, the lower its costs. Countries will export those goods that require intensive use of factors that are abundantly available locally and will import goods that make intensive use of goods that are scarce. This theory tries to explain the pattern of international trade in the world economy and assumes that free trade is mutually beneficial. It argues that international trade is determined by differences in factor endowments rather than differences in productivity. It is relative not absolute endowments that are important. It states that a country’s trading performance will depend on how different factor

endowments are across countries when they start trading. This theory is the core of modern trade theory.

4. Mercantilism

This theory states that government intervention is the dominant driver of international trade. Historically, a country’s wealth was measured by its holdings of treasure (gold). This translated into the conviction that countries should export more than they import, and if successful receive gold from countries that run up trade deficits. This theory impacted government policies by ensuring that their counties exported more than they imported by restricting imports and subsiding production that could not compete in domestic and export markets. This practice was unsustainable when home-based companies acquired technological leadership, ownership of raw materials abroad, and some degree of protection from foreign competition. Today neo-mercantilism has concealed the drive of mercantilism. This theory states that countries run a favourable trade balance in an attempt to achieve a political or social objective. This often results in an excessive state intervention in a country’s economy. This theory is flawed because it maintains that trade is a zero-sum game in which a gain by one country results in a loss by another. Recently, neo-mercantilism has effected state intervention by equating political power with economic power, and economic power with a balance-of-trade surplus. Such counties boost their exports and limit their imports due to state intervention.

5. Product Life Cycle (Raymond Vernon)

This theory highlights the USA’s former dominance over a period of time, in developing new products such as cars, televisions, cameras, computers, etc. this stems from the country’s preference to develop numerous consumer products as a result of consumer wealth and market size. However, not all products come from USA. Many new products originate from low cost production locations abroad, from where these products are exported to the USA. Vernon argued that many of the new products being exported overseas continued to be produced in USA. He argued that pioneering firms preferred to keep production close to the market and decision-making. This would safeguard them from risks associated with product development and distribution. He concluded that the demand for new products is based on non-price factors, and pioneering firms can charge relatively high prices for new products, which avoids the need for low-cost production sites. His reasoning was based on a particular focus on the life-cycle of a typical new product, the demand for which was growing rapidly in USA and limited to high income groups in other advanced countries. This forced these countries to import the new products rather than produce them themselves. This trend changed over time as demand for new products in these advanced countries started to grow. This then triggered the decision for these other countries to produce these new products in their home market. Consequently USA companies set up production facilities in those advanced countries abroad. This then limited the potential for USA to export. The completion of this cycle can be seen in advanced nations overseas whose market for these products are maturing, which meant that product standard and price became the main competitive weapons. Now producers operating in low cost locations are more likely to export to USA. This cycle of product development in USA eventually loses its advantage to overseas countries and will probably start repeating itself as other developing countries acquire a production advantage over USA. This could mean that USA may even become an

importer of these products. This theory suggests continued global domination by USA through its manufacturing expertise, unique staffing policies and technological innovations.

6. National Competitive Advantage (Michael Porter)

The diamond of national advantage was developed by Porter and this theory states that there are four attributes which are important for competitive superiority. He stated that these attributes of a nation shape the environment in which local firms compete. The attributes are as follows:

● Demand conditions

Firms start up production operations close to a potential market which is sustainable enough to drive a strong demand to justify the firm’s manufacturing operation.

● Factor conditions

A country has a competitive advantage when it has an absolute advantage pertaining to the availability of natural resources, and the relative availability of factors of production compared to other international locations.

● Related and supported industries

These must be in close proximity to a firm’s production facility. This emphasises the competitive advantage flowing from supporting facilities in similar industries.

● Firm strategy, structure and rivalry

The sustainability of the firm’s strategy, structure and rivalry potential that is important. For example, if barriers to market entry are low one can expect intensive rivalry between competing firms.

Porter incorporated two additional variables which can influence the national diamond. These are chance and government policies. Chance could include major innovations which shape the structure of industries and markets, allowing one country to supersede another in global competitiveness and market domination. Government policies refer to policies and regulations which can improve or detract from competitive advantage. Porter argued that firms are most likely to survive international competition when supported by these attributes. The effect of one attribute is dependent upon the state of others. Expansion of the national diamond through globalisation can improve the country’s business environment and make it more competitive.

7. New Trade Theory (Paul Krugman)

This theory states that in certain circumstances countries should specialise in the production and export of particular products, not on the account of differences in factor endowments, but because in certain industries the world market can only support a limited number of firms. This is the case in commercial airline industries. Firms that enter the market first are able to build a competitive advantage that is at first difficult to challenge. Recently, through product innovation and technology, market dominance has been successfully challenged.

Trade barriers

These instruments of trade control are used by governments to constrain economic relations between countries, hereby influencing imports and exports.

Reasons for trade barriers

● Protection of local jobs

Used as reason by governments when intervening in the regulation of trade flows. Leads to higher prices that cost consumers and make domestic products less competitive in the global market.

● Infant industry argument

Governments who provide support for new industries through tariffs, import quotas and subsidies until the new industry is strong enough to compete with international firms. Protectionism, however fosters inefficiency. It is better for these industries to borrow from financial institutions and markets. Given its comparative advantage, these industries should survive initial start-up costs.

● Import substitution

Volatile prices for key products cause unstable unemployment and incomes. This together with the cost structure of manufacturing inputs often renders the manufacturing process vulnerable and uncompetitive. Such countries resort to import substitution strategies by levying heavy import duties on those materials required for manufacturing forcing manufacturers to source inputs locally. This lays the foundation for infant industries while strengthening their technical and industrial skills base which promotes an integrated, diverse economy. However if protected industries do not become efficient, local consumers will end up subsidising them through higher prices and taxes. The solution – export led economic development. Unfortunately, import substitution may guarantee home market protection, but it will lead to a lack of advantage in international markets.

● The use of restrictive standards

Restriction in international service business by setting technical and professional standards that may be difficult for firms and individuals to meet. Done by setting strict licensing and professional educational standards.

● Reducing inordinate reliance on foreign suppliers

Through international supply chain networks, foreign suppliers are able to set prices. Governments may influence local industrialists to use preferred suppliers whose pricing models are more open to negotiation, thereby allowing industrialists to secure competitive prices for inputs. This implies exploiting home-based suppliers in order to secure a more viable competitive advantage.

● Restricting the use of subsidies

Government limitation of funnelling subsidies to selected industries which are strategically important to the economy. This means channelling allowances to investors and industrialists who favour the local production of specific goods that are strategically important. This means using tools and mechanisms that are geared to influencing the passage and destiny of FDIs.

● Controlling the balance of trade payments and deficits

The rise of a country’s productivity relative to other trading partners will improve its competitive position. The more FDI that is attracted to a country, the greater the demand for its home currency. Such positive changes in productivity will change a country’s trade balance. Highly productive means trade surplus, less productive means trade deficit. These have consequences for a country’s balance of payments. Governments must regulate its trade flows, service trade and capital movements so as to manage its balance of payments, with the aid of government interventions or through the use of monetary and exchange rate policies.

● Export promotion

Introduction of export promoting strategies to encourage and support specific industries in which a country can compete successfully. There are two catalysts to export expansion namely: -incremental internationalisation which presupposes that as a firm gains experience and results, can it progress into export mode, moving into a country dissimilar to its own, and, -the fact that some firms are born global, implying that they can export in an early stage of their lifecycle.

● Anti-dumping policies

Dumping is the selling of goods in a foreign market at below their cost of production, or selling them below their fair market value. It may enable foreign producers to subsidise their product prices in a foreign market, and once they have driven out foreign competitors, they can then increase their prices. Anti-dumping policies are aimed at penalising foreign firms that engage in dumping via trade regulation. Some tariffs are substantial and stay in place for up to five years.

● Political retaliation to achieve specific objectives

Pragmatic nationalism views FDI both as a benefit and a cost for their country. It is the disadvantages that cause countries to retaliate. In pursuit of specific political or economic objectives, countries adopt a realistic stance and design policies that maximise national benefits and minimise national costs. Often countries are motivated to retaliate against countries who have poor human rights records, child labour, sweat shops, political tyranny and totalitarianism. This could be in the form of trade barriers targeting offending countries.

● Protection of national sovereignty

Such protection implies the accommodation of local interest which should prevail over global interests.

The implications of trade barriers include the following:

● They are random and biased and applied subjectively. They could stem from political

motives rather than economic ones.

● The assumption that their use requires special training, supervision and administration.

● The prospect of their adding to the microeconomic problems, like inflation.

● They encourage special interest privileges – special discounts to certain trade alliances.

● Increased government intervention.

● Reflection when imposing them as plans are put in place to facilitate free flow of goods,

input materials and services across international borders.Trade control

Trade controls are divided into two groups:

1. Those that indirectly affect the amount traded, by directly influencing the prices of exports or imports

2. Those that directly limit the amount (quantity) of goods that can be traded.Further distinctions are:

● Tariff barriers

Taxes levied on imports or exports. Tariff barriers directly affect prices. A tariff (duty) is the most common type of trade control and a tax that governments levy on goods transported internationally. Tariffs collected by the exporting country are called export tariffs, if collected by the country through which the goods pass they are called transit tariffs, if collected by the importing country are called import tariffs.

● Non-tariff barriers

May directly affect either price or quantity. They limit trade by enabling governments to alter product prices or the quantity of goods traded.

Tariff barriers

Trade restrictions via the imposition of tariffs allow governments to pursue certain political and economic actions deemed to be in the interest of trade flows and their impact on the country.

Import tariffs

Tax imposed on imports. This tariff effectively raises prices or it influences the quantity of foreign goods coming into a country. Governments gain because tariffs increase government revenue and domestic producers gain because tariffs afford some protection against foreign competition by increasing the cost of foreign goods. Consumers lose because they must pay more for certain imports. This may be due to imposition of an ad valoreum tax which is based on a percentage of the value of the imported item in the destination country. Import tariffs restrict supply thereby raising domestic prices. They reduce the overall efficiency of the world economy – domestic firms encouraged to produce locally that could have been produced more efficiently abroad. This leads to ineffective use of resources.

Export tariffs

The objectives are as follows:

● Raise government revenue through increases in global sales volumes

● Encourage foreign MNC’s to initiate FDIs into the home country as a means of countering

the threat of trade barriers.

● Use it to increase the cost of exporting, relative to FDIs and licensing

● Justify FDIs being preferred over exports as a means of entering foreign markets.

● Diversify a MNCs customer base with home markets, ensuring capabilities and skills in the

home country.

● Enable MNCs to stabilise fluctuations in sales associated with economic cycles or seasonality

of demand by safeguarding their undue exposure to volatile international markets and minimise risks.

● Lower the aggregate costs associated with foreign market entry

Subsidies

Direct assistance from government in the form of a payment (cash loans, low interest rates, tax breaks and government participation in domestic firms) to companies to try make them more competitive. They achieve this by lowering production costs in order to help domestic producers. They do so by:

● Helping them compete against foreign imports

● Gaining export markets

In the interest of increased operational efficiency in those sectors (primarily agriculture) benefiting from subsidies, they will have to phase them out.

Non-tariff barriers (quality controls)

Import quotas

It is the most common type of quantitative import or export restriction in a given time frame. Import quotas raise prices because they limit supply, and they provide little incentive to use price competition to increase sales. Tariffs increase government revenue while quotas only generate income for those firms that are able to obtain and sell a portion of the limited supply of the product. Import quotas are not necessarily imposed to protect domestic producers, rather countries maintain quotas on products produced in a country. They do so by allocating importing rights to competing domestic firms in exchange for increased exports.

Voluntary export restraints (VER)

It is a quota imposed by the exporting country, typically at the request of the importing country’s government. Import quotas and VERs benefit domestic producers by limiting import competition. VERs always raise domestic prices of imported goods due to the limited foreign supply of a particular product subject to a VER quota. VERs can have negative effects on political relations between affected countries.

Local content requirements

Governments may pressurise manufacturers to make a greater share of a given product in the local market. This LCR may be expressed in physical terms, as a percentage of component parts for a product to be produced locally, or in value terms for example 75% of the value must be produced locally. LCRs provide protection for domestic producers by limiting foreign competition. The restriction on imports raises the prices of the imported components, meaning the price of the final product is higher to consumers.

Technical barriers

They are introduced to discourage imports. For example, imposition of rigid environmental standards or high product standards may serve as a deterrent.

Free trade

Free trade emanates from the principles of absolute advantage. Free trade prevents wastage of national resources, which is due to the practice of minimising imports. Free trade forces should determine how much trade should be allowed with little or no government intervention. Free trade allows the possibility of countries sharing the advantages generated by trade activities in a way that favours their citizens. Free trade has brought down trade barriers to the reach of goods, it has succeeded in enhancing international interdependencies, which have the power to influence both markets and nations. Free trade seeks to restore the force of the global economy.

Trade protectionism intrudes on the process of global integration.

Chapter 10 – foreign Direct Investment and the Institutional framework